Inflation Data: Is the Economy Healthy?

Standards

Concepts

This series of lessons will introduce you to economic data that economists use to assess the health of the economy. You will learn about economic data and what they communicate about the health of the economy. This lesson focuses on the Consumer Price Index (CPI) as a measure of inflation, which is important data for analyzing the health of the broader economy.

Introduction

ESSENTIAL QUESTION: What do current inflation data say about the health of the economy?

This lesson is part of a series that asks students to assess the current health of the economy by examining current economic data. This lesson focuses specifically on inflation data provided by the Bureau of Labor Statistics and available on the St. Louis Fed’s FRED data website. Students will learn what the Consumer Price Index (CPI) measures, what an inflation rate is, and then conduct an analysis of the current inflation rate relative to the Federal Reserve’s inflation target to make an assessment of the current economy’s health.

Process

1. Ask the students if they have been to the doctor for a health check-up recently. Remind students of the routine: A nurse likely started the process with some routine tests to collect information – perhaps she strapped a band around your arm and pumped it full of air to test your blood pressure. Then she might have taken your temperature, looked in your ears and eyes with a light, and tested your reflexes with a small hammer.

2. Ask the students why all of this was necessary. Students might suggest that the nurse is collecting information about how your body is functioning. Tell students that this process is “data collection.”

The nurse collected relevant information on your health to be assessed by the doctor. The initial data check helped the doctor identify potential problems – determining if there were any data that seemed out of order.

If everything checked out, the doctor likely gave you her assessments, maybe some advice on eating healthy and exercising, and bid farewell until your next appointment.

If, however, the data showed some irregularities, the doctor likely asked for further tests – collecting more data to observe. Many times the doctor’s diagnosis requires treatment – prescription medicines or even surgery.

All of this is meant to check the state of your health, and if it is needed, to use treatment strategies to return you to health.

3. Tell the students that the economy, like the human body, is extremely complex. And like the body, most times the economy functions very well on its own. However, there are times when the economy suffers maladies such as recessions or periods of high inflation that require treatment. And like the body, early detection of potential problems will prevent more serious issues and will likely mean less invasive treatment.

4. Tell the students that economists use economic data to assess the health of the economy. And economists use economic data to assess whether treatment is necessary.

5. Define inflation as a rise in the general, or average, price level of all the goods and services produced in an economy. Tell students that inflation reduces the purchasing power of money. For example, if inflation was 2 percent last year, your money will purchase about 2 percent fewer goods and services than the same amount of money could purchase last year. The most common measure of inflation is the Consumer Price Index (CPI). Display Visual 1: Key Facts about CPI and discuss the key information about CPI.

7. Ask students to guess what the current inflation rate is. Make a record of the range of guesses.

8. Ask students: Which is best, high inflation, low inflation, zero inflation, or negative inflation? Ask students to explain their answer. Tell students that a low and stable rate of inflation is ideal. When inflation is low, money loses purchasing power at a very slow rate. If inflation is stable, or constant, it is easier to make decisions about spending, saving, and investing for the future.

10. Remind the students that CPI data are released monthly, that CPI is reported as an index number, and that it is reported as a level. Display the Inflation Economic Data Dashboard to show the current level.

Refer to Box 1 and ask students to describe the trend since 1948 on Activity 2. (The trend is a steady, upward sloping line.)

Ask students to record the current (most recent) CPI level on Activity 2 (using Box 2).

11. Tell the students that knowing the level is helpful, but it is also useful to know how quickly prices are rising, or the inflation rate. Think of driving on an interstate highway – it is important to notice forward progress (miles traveled) toward your destination (this is a level measure), but it is also useful to measure your rate of progress (your speed, measured in miles per hour). Give each student a copy of Activity 2: Calculating the CPI Inflation Rate. Tell students to work through the activity, providing support as necessary.

12. Ask students why inflation is important. Tell students that as the price level increases, the purchasing power of money decreases. People pay attention to the inflation rate because it tracks how quickly prices are rising. For example, if the annual inflation rate is 4 percent, money is losing purchasing power at a rate of 4 percent per year. This means that, on average, the things you buy this year for $100 will cost you $104 next year.

Examine the graph in Box 3. The line indicates the inflation rate. A positive number indicates inflation. Ask students how the CPI inflation rate since the year 2000 compares to the period from 1970 to 1985. (The inflation rate was much higher from 1970 to 1985 than in the years since 2000.)

Tell students that deflation is a sustained decrease in the average price level of all the goods and services produced in the economy. Deflation is indicated by a negative inflation rate. Periods of deflation are often associated with periods of severe recession. Are there periods of deflation on the graph? If so, when did they occur?

Tell students that a recession is a decline in the rate of national economic activity, usually measured by a decline in real GDP for at least two consecutive quarters (i.e., six months). What typically happens to the inflation rate during a recession? Is there a pattern? (The inflation rate often decreases during a recession.)

14. Tell the students that while some people might think inflation is a bad thing, economists think that a little inflation is actually a positive thing because it protects against falling into deflation.

15. Tell the students that economists are quick to point out that one data point does not indicate a trend. Ask students to use the data in Box 4 to record the six most recent CPI inflation rate readings on Activity 1. What has the recent trend been?

16. Now that you have an idea of what the data says about the current economy, it is important to compare the data to some benchmark. Using our doctor illustration, your doctor will compare your blood pressure to the acceptable range – if the reading is too low or too high, it might indicate a health problem.

17. The inflation benchmark is the Federal Reserve’s inflation goal. Tell the students that the Federal Reserve, like many of the world’s central banks, has set a goal, or target, for the inflation rate. If the inflation rate is deviating higher or lower than the target, the Federal Reserve can use its monetary policy tools to move inflation toward the target.

The Fed has a 2 percent goal, or target, for the inflation rate. Two percent inflation is high enough to provide a buffer against deflation (negative inflation) but low enough that it doesn’t erode the purchasing power of money very quickly. For more information, see this webpage .

Tell students that while inflation can be volatile over short periods of time, over longer periods of time the goal is for the inflation rate to stay close to 2 percent.

Tell the students that the Federal Reserve can use its monetary tools to raise or lower interest rates to influence the inflation rate.

Refer students to the Inflation Economic Data Dashboard and Box 5. Tell the students that this graph shows the inflation rate of the economy using two different measures of inflation – the CPI and the Personal Consumption Expenditures (PCE).

The Federal Reserve uses the PCE measure of inflation to check whether it is achieving its 2 percent inflation goal.

Tell students that the green horizontal line represents the Federal Reserve’s 2 percent target. Ask students whether it looks like the Fed has been successful in keeping the inflation rate near its target in recent years. Ask students to record their analysis on Activity 1.

18. Because inflation data tends to be volatile, it can be difficult to determine trends. As a result, economists sometimes include other measures of inflation in their assessment. They often include “core inflation” in their assessment, which leaves food and energy out of the market basket. These items are excluded because their prices tend to be very volatile. One common measure of core inflation is Core CPI (Consumer Price Index for all Urban Consumers, All Items Less Food and Energy). Changes in core inflation can help economists identify trends that might influence the CPI inflation rate. For more on different measures of inflation including core, see this webpage .

Refer students to the Inflation Economic Data Dashboard and Box 7 and 8. Record inflation and Core Inflation data on Activity 1. Are there differences between the CPI and the Core CPI recently?

Discuss key content with students to ensure they understand what the inflation rate reveals about the health of the economy. Ask the students to describe their assessment of the economy and defend it using data.

Conclusion

Inflation is a rise in the general or average price level of all the goods and services produced in an economy. CPI measures inflation, which is important because inflation reduces the purchasing power of money. The inflation rate is calculated as the percentage change in the CPI from one period to another. An inflation rate that is too high can cause economic problems and so can deflation. The Fed has a 2 percent goal, or target, for the inflation rate. Two percent inflation is high enough to provide a buffer against deflation (negative inflation) but low enough that it doesn’t erode the purchasing power of money very quickly.

Extension Activity

FRED data is available for the state, county, and Metropolitan Statistical Area (MSA). For example, click the following links to examine economic data about Minneapolis, MN. Use FRED to find data about your local economy and write a short economic report about the state of the local economy. Start by entering the name of your city, county, or state in the search box on this page.